Jury Finds Against SEC On Most Claims In Financial Fraud Case

by Dorsey & Whitney LLP

The jury in SEC v. Life Partners Holdings, Inc., Civil Action No. 1-12-cv-00033 (W.D. Tx. Verdict Feb. 3, 2014) rejected most of the Commission’s claims which centered around an alleged financial fraud. This is one of a series of recent set-backs the SEC has suffered in the courtroom.

The action was brought against Nasdaq traded Life Partners Holdings, Inc. and its chairman and CEO, Brian Pardo, along with president and general counsel, Scott Peden, among others. The complaint alleged that the defendants misled shareholders by failing to disclose that the company was systematically and materially underestimating the life expectancy estimates it used to price transactions.

Most of the revenue of the company is derived from brokering life settlements which involve the sale of fractional interests of life insurance policies whose value is keyed to the insured’s life expectancy. For this purpose the company used life expectancy estimates provided by a doctor with no actuarial training or prior experience in this area, according to the complaint. No meaningful due diligence was conducted to determine if the doctor’s methodology and qualifications were appropriate.

The complaint claimed the two officers were aware that the estimates were systematically and materially short. Nevertheless, between February 2007 and January 2009 Messrs. Pardo and Peden sold, respectively, about $11.5 million and $300,000 of Life Partners common stock based on inside information “that the firm’s stock price was dependent on its practice of systematically using materially short . . .” life expectancy estimates, according to the complaint. The Commission also claimed that from fiscal year 2007 through the third quarter of fiscal 2011 the company prematurely recognized revenue and understated impairment expense related to its investment in life settlements. Violations of Exchange Act Section 10(b), 13(a), 13(b)(2)(a) and 13(b)(5) and Securities Act Section 17(a) were alleged. The complaint also demanded the repayment of certain stock sales profits and bonuses under SOX.

Prior to jury deliberations the parties disagreed on the precise scope of the claims being advanced by the SEC. Defendants sought the entry of a judgment in their favor based in part on a contention that the Commission “failed to introduce any evidence at trial to support any of its revenue recognition claims . . .” The Court rejected that motion and presented the then existing claims for consideration by the jury. Those claims were summarized by the Court in the instructions. There jurors were told to consider nine specific claims (grouping the aiding and abetting charges together with the primary claim for purposed of brevity):

1) Securities fraud under Exchange Act Section 10(b) against the three defendants for making material misstatements regarding “a material risk to the Company’s business . . . or a material trend impacting the Company’s reserves . . .” The jury rejected this claim.

2) Insider trading against the two individual defendants. The jury rejected this claim.

3) Securities fraud under Securities Act Section 17(a) against the three defendants for making misrepresentations or omissions “regarding the company’s revenue recognition policy.” The jury found in favor of the SEC as to each defendant.

4) Section 13(a) and Rules 12b-20, 13a-1 and 13a-13 against the company (and aiding and abetting violations by the individuals) for filing “Forms 10-Q, 10QSB, 10-K and 10-KSB with the SEC that contained false statements . . .” The jury found in favor of the Commission on these claims.

5) Exchange Act Sections 13(b)(2)(A) and 13(b)(2)(B) as to the company (and aiding and abetting as to each individual defendant) for failing “to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurance that . . .” transactions were recorded as necessary and such that the firm could maintain accountability of its assets. The jury found against the SEC on these claims.

6) Exchange Act Section 13(b)(5) as to the two individual defendants for either falsifying the books and records of the company, circumventing its internal controls or failing to implement a system of internal accounting controls. The jury rejected the SEC’s claims.

7) Exchange Act Rule 13b2-1 as to the two individual defendants for falsifying “any book, record or account . . .” of the firm. The jury rejected these claims.

8) Exchange Act Rule 13b-2 against each individual defendant for making a false or misleading statement “to an accountant in connection with (i) any audit . . . . or (ii) the preparation or filing of any document or report required to be filed with the Commission.” The jury found against the SEC on these claims.

9) Exchange Act Rule 13a-14 against Mr. Pardo for certifying a report of the firm filed with the Commission that contained a misrepresentation or omission. The jury found in favor of the Commission on this claim.

According, the jury found against the SEC on six of nine claims and in its favor on three. The jury rejected the primary fraud claim against the defendants which was based on alleged misstatements or omissions regarding essentially the business model of the company and the related insider trading charges while concluding that the defendants made a filing with the Commission which misrepresented the revenue recognition policy of the business. Life Partners is the fifth case in which the Commission has lost either all or the key claims at trial since late December 2013 – less than sixty days.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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